Forget about the Dow Jones Industrial Average: America’s real index is the S&P 500. The measure of the 500 largest stocks by market-cap is a more accurate depiction of the economy and covers nearly 80% of our country’s market-cap. The index covers all the main sectors, stalwarts and stocks critical to the nation’s inner economic workings.
Given the breadth and size of the index, it’s no wonder investors use it as a guide.
Today, more than $7.8 trillion of investor money is benchmarked to the S&P 500. Of that hefty sum, a full $2.2 trillion is directly tied to the benchmark via index funds. There’s more than $305 billion of investor cash sitting in the SPDR S&P 500 ETF Trust (SPY), iShares Core S&P 500 ETF (IVV) and Vanguard 500 Index Fund (VOO) exchange traded funds alone.
And there lies potentially the problem.
While matching the index is great, investors may be leaving money on the table. There are still plenty of things inherently wrong with the revered S&P 500. And that’s where smart-beta funds come in. These funds use various screens and alternative weighting methods to track the venerable S&P 500. All which should drive outperformance over the long haul.
For investors, smart-beta funds could be the best way to track the S&P 500. Here are three of the best.
The Best S&P 500 Smart-Beta Funds: Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC)
Expense Ratio: 0.09%, or $9 per $10,000 per invested
The heart of the smart-beta movement is using fundamental screens in a parent index — like the S&P 500 — to find the “best stocks.” The Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC) is a prime example of this.
GSLC applies screens to the venerable index and looks for measures of earnings quality, strong momentum, low volatility and whether a stock is a good value. These are considered the four pillars of smart-beta funds that lead to index-beating outperformance. Basically, the smart-beta ETF kicks out all the bad stocks and keeps in all the good.
Right now, that’s about 436 stocks in the parent index, which includes S&P 500 staples like Apple Inc. (AAPL) and Home Depot Inc (HD).
And while kicking out those 60 or so stocks from the S&P 500 hasn’t materialized in outperformance in the fund’s very short history, it has actually underperformed the SPY by about a percentage point. Over the long-term, the stock market is a weighting machine, where the best stocks thrive. Therefore, GSLC should be able to post great returns
And at just 0.09% in expenses, GSLC makes a prime way to add a dash of smart-beta to your S&P 500 index holdings.
The Best S&P 500 Smart-Beta Funds: Guggenheim S&P 500 Equal Weight ETF (RSP)
Expense Ratio: 0.40%
One of biggest problems with the S&P 500 is that it’s a market-cap weighted index. That means bigger stocks in the index — such as Exxon Mobil Corporation (XOM) — have more assets of the fund than smaller firms like Owens-Illinois Inc (OI). It also means that XOM’s performance can move the index more than OI’s can.
This bias toward larger, slower moving stocks can zap returns, and the potential of smaller and faster-moving firms can’t really be felt. However, an equal-weight strategy, where all stocks have a similar weight in the index, can alleviate this fact. The Guggenheim S&P 500 Equal Weight ETF (RSP) does just that.
It holds all the stocks in the S&P 500 in roughly equal proportion, which means XOM has the same percentage in assets as OI. And the proof is in the pudding. As of the end of the first quarter, RSP has managed to beat the regular S&P 500 by over 1.1% annually, for the last five years.
Note, however, that there have been periods of underperformance for RSP, especially in risk-off markets. But the overall long-term trend is higher.
The Best S&P 500 Smart-Beta Funds: PowerShares S&P 500 Low Volatility ETF (SPLV)
Expense Ratio: 0.25%
Volatility could be one of the worst return killers of all. Portfolios that jump around too much and have really high highs and really low lows can actually significantly underperform those that have much smoother rides.
This is where the PowerShares S&P 500 Low Volatility ETF (SPLV) comes in handy.
SPLV attempts to smooth-out the ride of the S&P 500 by screening for those stocks in index that exhibited the lowest volatility over the last 12 months. Basically, it holds the 100 firms that don’t jump around by as much and equal weights them.
By strictly looking at volatility, it creates a much different set of firms than the broader S&P 500. Top holdings in SPLV include Waste Management, Inc. (WM), The Coca-Cola Co (KO) and Dominion Resources, Inc. (D).
Notice anything similar about those holdings? That’s right … they are dividend stalwarts. It turns out that low-volatility stocks tend to be big-time dividend payers as well. That allows investors to use SPLV as a way to squeeze a little more income out of their portfolios as well.
That has helped it outperform the broader S&P 500. Since its inception back in 2011, SPLV has managed to put up a 13.51% annual return to the regular indexes return of 11.71%.
As of this writing, Aaron Levitt was long RSP.
